When an investor has a controlling voting interest in another enterprise, most
countries’ standards require that the investee be consolidated. One major disagree-
ment between accounting standard setters in various countries is whether nonhomo-
geneous or dissimilar subsidiaries should be consolidated, even where control exists.
Standards that support consolidation of nonhomogeneous or dissimilar subsidiaries,
such as IAS and U.S. GAAP, are based on the premise that the financial statements
of an enterprise should present all the assets and liabilities under the enterprise’s con-
trol. Alternatively, some countries, such as Italy and China, have taken the position
that consolidation of dissimilar subsidiaries may be misleading and confusing to the
reader of the financial statements. Ironically, in those countries that have required
nonhomogeneous operations to be consolidated, analysts have sought more extensive
disaggregated disclosure.
The most difficult aspect of the consolidation standards concerns the definition of
control and its application to specific facts and circumstances. U.S. GAAP currently
embodies what may be described as a legal concept of control. That is, to obtain con-
trol of the enterprise usually requires that the controlling entity have the direct or in-
direct ability to elect or appoint a majority of the members of another company’s gov-
erning board. In the United States, the notion of control encompasses control
obtained by ownership or by agreement with other shareholders. IAS 27, “Consoli-
dated Financial Statements,” also requires controlled entities to be consolidated but
relies on a definition of effective control. Thus, it is likely that more entities would
qualify for consolidation under IAS 27 because of the IASB’s emphasis on effective
control rather than on ownership of a majority voting interest. The U.S. standard set-
ters have proposed changes to the accounting rules relating to consolidated financial
statements that would, if adopted, broaden the notion of control to include situations
where an enterprise has effective control over another. The effective-control concept
significantly extends the circumstances under which consolidation would be required
and, in particular, has the potential to eliminate certain off-balance-sheet finance
structures. Let’s look at one condition that might give rise to effective control under
the proposals. First, absent evidence to the contrary, ownership of a large minority in-
terest (approximately 40%) of a publicly traded company in circumstances under
which no other party or organized group of parties has a significant interest would be
said to give rise to effective control. Accountants have criticized this outcome be-
cause the enterprise’s ability to retain control in these circumstances is reliant on the
existence of conditions that may be temporary and beyond the so-called controlling
enterprise’s “control.” For example, another party may suddenly emerge on the stock
register as a significant minority shareholder and seek to assert its will on the com-
pany in question. That party may subsequently sell down its interest, leaving the first
enterprise with effective control once again. For the enterprise to continually consol-
idate, then deconsolidate only to subsequently reconsolidate the same target is not
viewed by everyone to be either desirable or to be resolving an existing practice prob-
lem that anyone can point to. Further, it seems to be contrary to the notion of control
that an enterprise may lose control without relinquishing any rights.
Another set of circumstances that may give rise to effective control are those in-
stances in which special-purpose vehicles (SPVs) are employed by an enterprise to
obtain structured finance. The party providing or organizing for substantially all of
the funding is typically an investment bank. The enterprise may provide collateral in
the form of noncancelable lease commitments or through a variety of other mecha-
nisms. In these arrangements, the enterprise may control all of the residual benefits
12.6 FINANCIAL STATEMENT EFFECTS 12 • 23